Every Man a Jed Clampett

How to speculate on oil without getting your hands dirty


It will not escape the notice of astute readers that heavier-than-air flight requires a fair amount of energy. As a consequence, oil takes up a pretty big chunk of most airlines' operating budgets. So alarms should go off when normally oppositional, hyper-competitive airline companies suddenly join forces, urging all of their frequent flyers to write to their representatives in Congress to Stop Oil Speculation Now!

"Twenty years ago," says a letter [PDF] signed by dozens of airline execs and blasted into thousands of frequent flyer inboxes, "21 percent of oil contracts were purchased by speculators who trade oil on paper with no intention of ever taking delivery. Today, oil speculators purchase 66 percent of all oil futures contracts."

Sounds bad, right? "A barrel of oil may trade 20-plus times before it is delivered and used," the airline execs warn. Greedy speculators manipulating oil prices just by pushing paper around? Just who are these speculators, callously driving up oil prices and "hurting our families"? Well, for starters, the airlines themselves.

For years, the stunning success of Southwest Airlines has been a staple feature story on the business pages of major newspapers. In an era of rising prices and busted planes, Southwest seems to float above the fray. Even as the bottom lines of their airborne brethren fall ever lower—other airlines reported a collective $6 billion loss this quarter—Southwest is reporting its 69th consecutive profitable quarter. Tickets are still pretty cheap, and there are no new surcharges for checked bags, something the company has been making much of in its ads.

Southwest itself credits its profitability to savvy, forward-looking commodities hedging to compensate for higher fuel prices. In fact, the company has saved about $3.5 billion with hedging since 1998, a figure equal to 83 percent of its profits over that time. Hedging means that a company locks in a price for oil at a fixed date in the future by signing a contract today promising to buy the oil at that price, no matter what happens to the market in the interim. If prices go up, Southwest speculators get to buy below-market rates. If prices go down, they have to pay more than their competitors for the same oil.

"When oil got to $40 a barrel, we thought, 'Oh, wow! It's too late.' Then it went to $60, and to $80, and then to where we are now," Southwest Treasurer Scott Topping told USA Today this week. Topping is in charge of Southwest's hedging operations. "At each step along the way, the question 'Is this something we should continue to do?' became more and more difficult to answer. But our overall philosophy led us to keep buying hedges. It's a matter of discipline." Southwest has hedged so well that the company paid about $2.35 a gallon for jet fuel this quarter. Those with less speculative skill would have had to cough up $3.95 for the same gallon on the spot market.

Southwest, which also signed the Stop Oil Speculation spam, isn't the only airline to hedge on the price of oil?they all do, just not nearly as successfully. Apparently, when airlines buy oil futures on a bet that the prices will eventually go up, it's good business practice, but when people who don't happen to be the treasurers of airlines do the same thing, it's "rampant speculation" that "upsets the natural relationship between supply and demand."

And then there's that other greedy speculator: You. Anyone with a 401(k) or some kind of retirement benefit coming to them probably has a portfolio containing commodities futures, which are increasingly appealing as the dollar falls and the real estate market continues to reel. Or perhaps you own a bit of Southwest stock, which has a pleasing price these days. Futures contracts exist for all kinds of commodities, and the logic is always the same. It's similar to buying stock, or even buying a house. You're hoping to make a smarter bet than the other guy on which way the prices are going to go. It's how markets work. If there were no "speculators," you'd have no 401(k) and airlines would have to change prices every time Hugo Chavez managed to get ahold of a microphone.

The main concern about speculation, and the reason that the trading of many commodities (like onions, for instance) is regulated, is fear that one company might corner the market. Historically, most efforts to corner markets fail, so the danger of prices skyrocketing after a successful attempt is minimal to begin with. But the fear of futures contracts, or speculation, is even more absurd when the commodity is oil. The energy markets are international and incredibly dynamic. Congress can't really prevent people from speculating on commodities in London or Dubai, no matter how much it would like to, so speculation will carry on, affecting the prices Americans pay for oil, whether or not the bet is placed on our shores. A bill that looks a lot like the airlines' list of demands is currently stalled in the Senate, but it came close to passing earlier this week.

It's possible that no amount of speculation will make much of a dent in the price of oil, at least compared with the ever-growing demand for oil from India and China. In their letter, the airlines claimed that "current prices reflect as much as $30 to $60 per barrel in unnecessary speculative costs." But on Wednesday, a task force from the Commodity Futures Trading Commission found that "preliminary analysis to date does not support the proposition that speculative activity has systematically driven changes in oil prices."

And last month in The New York Post, reason contributor Alan Reynolds pointed out that since oil hit $100 a barrel, the number of speculators betting that the price will drop has increased dramatically. There are nearly as many traders who now think oil prices will fall as there are who think the price will rise. If prices keep going up, these guys are screwed. They're rooting for prices to go down, just like the rest of us, albeit for different reasons.

Frequent flyers are used to receiving all manner of useless promotional emails. "Fly to Siberia via Cincinnati and Rotterdam for only $363 one way!" The only difference is that the Stop Oil Speculation Now! email is worth little more than a stroke of the delete key. Compared to that, a trip to Siberia might actually be fun.

Katherine Mangu-Ward is an associate editor of reason.